Sarbanes-Oxley weighs heavy on biotechs

Australian companies contemplating a listing on Nasdaq have a new set of regulatory concerns to consider, with the introduction of the controversial Sarbanes-Oxley legislation in the US.

The Sarbanes-Oxley legislation, which was precipitated by the financial mismanagement of WorldCom and Enron, has now gone into effect for US listed companies, although foreign companies including the handful of Australian biotechs listed on Nasdaq have been given another year's grace to get up to speed with the new regulations.

But it's not just the legislation itself that is causing headaches, according to Ross Kaufman, a partner with US legal firm Greenberg Traurig LLP, who specialises in assisting Australian biotech companies with mergers and acquisitions, and with listing on the US financial markets. Nasdaq and other markets have tightened up their corporate governance rules, and some of the new rules also increase the burden on Australian biotech companies looking to list.

"Strictly speaking, Sarbanes-Oxley regulations include the 404 certification, which is the bane of all companies," Kaufman told Australian Biotechnology News recently. "Companies have to institute internal controls over their financial reporting, and auditors have to certify these financial controls."

For large companies, Kaufman says, this can be extremely expensive -- on the order of US$1 million just to put the appropriate processes into place. For smaller companies the costs are not quite as high, but it does mean the company has to put into place an internal audit function -- a burden on a company with a handful of staff.

"Some companies already listed may not have the wherewithal to do the internal controls and internal audit," he says.

On top of the 404 requirements, strict new corporate governance rules have also been put into place. Foremost among them is a requirement for the company board to have an audit committee formed entirely of independent directors, and including a member with expertise in US GAAP (generally accepted accounting principles). While Australia's own corporate governance guidelines for best practice are now recommending that boards be comprised of a majority of independent directors, the second requirement may be more difficult for small Australian companies to fulfil. And unfortunately, foreign companies are not able to claim exemption from the audit committee rule.

Other new corporate governance rules, such as one requiring that a quorum of 33 per cent of outstanding shares before calling a shareholders meeting, and the need for more independent directors on the board, may be subject to exemption for Australian companies, Kaufman says, particularly if there is no such requirement from ASIC and the ASX. Australian companies may also have to adjust their market announcements once they are working in the US environment, striking a happy medium between the norms of the two financial markets. In any case, Australian corporate governance rules are moving in a similar direction to those in the US, emphasising transparency and communication.

The bottom line is that Australian companies planning to list on Nasdaq need to make sure they are compliant with the US rules and regulations. And it's important to point out that the new rules and regulations only affect companies listing on the electronic boards -- companies embarking on level 1 ADR programs are not affected by the changes. But if they plan to move onto a level 2 ADR program which does entail listing on Nasdaq, it becomes a factor for consideration.

"It will definitely have an impact," Kaufman says. "[A company] might already have an audit committee and charter in Australia, and they need to make sure it is compliant, or else implement a compliant system. They also would need to look at the director's liability coverage to ensure it covers the Sarbanes-Oxley regulations.

"It involves work and with the 404 compliance it seems like overkill for smaller companies."

But Kaufman says that it isn't slowing down Australian companies in the process of listing in the US -- he's got five biotech companies doing small cap Nasdaq listings through the ADR program at the moment.

"I'm not hearing people saying that Sarbanes-Oxley has spooked them so that they are not going to list," he says.

Chasing a higher valuation

According to James Campbell, vice president of operations for Victorian company Chemgenex Pharmaceuticals, which is in the process of upgrading its level 1 ADR program to a level 2 ADR program allowing it to list on Nasdaq, the end result of Sarbanes-Oxley is substantially increased costs for the company, both upfront and ongoing. In addition, he says, a longer time is required to get the necessary US GAAP-compliant audit required to file the 20F form with the US Securities and Exchange Commission (SEC) prior to completing the ADR program.

"Because of the legal risks that Sarbanes-Oxley has created, audit companies have increased legal bills and heightened exposure to the SEC," Campbell says. "That gives them absolutely no margin for error."

It translates to more expense and time required for the company though -- while it used to cost in the order of $50,000 to perform the audit required and take six weeks to complete, it now costs upwards of $300,000 -- Campbell has heard figures as high as $700,000 -- and can take several months, putting considerably more burden on the company to make the appropriate decision.

"You have to weigh up carefully the cost-benefit," he says. "And that's before you list!"

Implementation of Sarbanes-Oxley compliant systems also required more formal processes and clear paper trials, as well as extra personnel. But Chemgenex has made the decision to move forward despite the increased costs and complications. Among the factors influencing the decision was the company's substantial base of operations in the US gained as a result of last year's acquisition of Chemgenex Therapeutics.

"Given that the costs had gone up, we looked in more depth at whether it was appropriate to continue," Campbell says. "But about 40 per cent of our shareholders are from overseas, mostly in the US, and we believe we're well placed to get an uplift in our share price when we list on Nasdaq."

Another company that has thought hard about the implications of Sarbanes-Oxley on their listing plans is Alchemia, which did its level 1 ADR program recently and is now moving toward a level 2 program.

"We did speak to people and were appropriately cautioned about it," says CFO Chris Neal. "But from our perspective, the US capital markets and Nasdaq are the right place for us. For biotech, the US is the major capital market."